Valuation, Portfolio Construction, and Lots of Companies

In this interview with John Rotonti of The Motley Fool, we really cover the waterfront. We talk about portfolio construction, valuation, and discuss the following companies:


Shopify, Wix, Slack, PayPal, Square, Twilio, Roku, Spotify, and Zoom. We also talk about the ecological approach we use, where we think of companies as organisms competing in a Darwinian jungle.


Even though this interview originally aired in October of 2020, I think it remains incredibly relevant, and I hope you enjoy it.

John Rotonti:

I am John Rotonti and this is My Investing Life, where I interview the investors I admire most to learn about their investment process and philosophy.


Today, I'm speaking with Marcelo Lima from Heller House. Marcelo is the Founder and Managing Partner of Heller House. Last year, I published an article about Marcelo in which I call him one of the best, and I meant every word of it. Marcelo is one of the most impressive thinkers and stock pickers I have come across. So, let's find out how Marcelo was able to achieve this outperformance for his investors. Marcelo, welcome. Please tell us about Heller House.


Marcelo P. Lima:

John, with that kind of introduction, it's really hard to live up to it, but thank you for the kind words and thank you for having me back. It's a pleasure to be here.


At Heller House, our mission is really to deliver investment excellence to our investors, and the way we do this is first by having this very strong alignment of interests where my family and I are the largest investors in the partnership, and then our goal is to compound our wealth over the long term. We do that by having a strong owner's mentality and by owning businesses that are disruptive innovators. Now you might ask, "Why is disruptive innovation important?"


Imagine we're back in the 1800s and we're investors in canal transportation companies, for example. That was a thing, and it was huge. You and I say, "You know what, we're doing super well, we're making all this money, we don't have to worry about technology." But then along comes the railroad. They completely decimated the canal companies, made them totally obsolete. And I chose the beginning of the Industrial Revolution, because that's when it started, but you see this pattern happening over and over again. Today, we're experiencing this across so many areas. So, unless you're an investor who understands the process of disruption and you're attuned to the latest technologies, you might end up investing in buggy whips without even realizing it.


So, we really try to identify these technological shifts, which create technology adoption curves. Some recent examples include the adoption of the internet, smartphones, cloud computing. They start at zero adoption and they grow over time. And then identify exceptional businesses riding those adoption curves.


To do this well, you need a combination of skills. You need to be a good financial analyst and understand how these companies will create value over time. You need to understand the technology well. Then you also need to understand corporate strategy and company culture, because if you're owning these businesses for a decade or more, those factors are incredibly important.


We have an incredible group of high-net-worth individuals and institutional investors who have joined us at Heller House as investors, and in a nutshell, that's what we do.


John Rotonti:

Awesome, Marcelo. So, would you say that your stock picking philosophy is investing in these innovative disruptors that are on these accelerated growth curves? Is that how you would describe it or another way?


Marcelo P. Lima:

That's right. We try to identify the best companies that have developing moats and are taking advantage of these adoption curves.


John Rotonti:

The last time we spoke, you said you like to invest in companies that are in a state of perpetual beta. What did you mean by that?


Marcelo P. Lima:

Yeah. So, it's funny because I read this book years ago and I was recently rereading this chapter, and I'll tell you what book it is. But beta is this term where you have a product that you're still testing, and perpetual beta is a phrase from this great book called Superforecasting, and it's this idea that you're never quite done. You're always applying a beginner's mind to the problems that you're facing, you're always improving, you have a growth mindset, and you're never satisfied. You're always subjecting your assumptions to criticism and examination. That's what perpetual beta means, and it's something that we look for in the culture of our companies, and obviously, something that I also apply to my thinking as well.


John Rotonti:

Perfect segue, because now I want to ask you about management and culture. The last time that we spoke, you also said that you are overweight corporate culture and management teams. What did you mean by that?


Marcelo P. Lima:

Many people use heuristics, or mental shortcuts, to make decisions. For example, some investors might look primarily at an earnings multiple as a starting point. My view is that things that cannot be easily quantified are still incredibly important, especially if you're the owner of a business over many years. Among those things, I think culture and the quality of the management teams are very, very important. I put a lot of weight on those factors when I'm considering an investment. Business is really hard and someone is always trying to outcompete you, always trying to eat your lunch, so having a great culture and leadership is crucial in the normal course of business, but it's really life or death in difficult times. And every business, even the greatest ones, will go through those difficult times, so you really want to have a fantastic team with a great culture running the show.


John Rotonti:

For sure. How do you narrow down your investing universe and how large is your investing universe?


Marcelo P. Lima:

The universe is quite big and it keeps getting bigger because we are going through so many different technological shifts right now. That naturally creates what I call this Cambrian explosion of interesting businesses, everybody competing to find out what combination of business model, go to market strategy, etc, will create the next winner. Our goal, then, is to go through these businesses systematically, understand them, and then find the ones that have the best characteristics, all these factors that we talked about: culture, management team, best customer acquisition strategy, it's really a very holistic approach, but it is a process of trying to drink from a fire hose and then cull it down to a more manageable number of companies.


John Rotonti:

Shifting gears slightly, what is your portfolio management strategy? How many stocks do you typically own? What is the size or weighting of a typical starter position? And then what is the size or weighting have a typical max position?


Marcelo P. Lima:

I'd like to talk about some general principles that I strongly believe in. There is evidence over long periods of time that stock returns are very highly skewed. What that means is, there's an analysis that's been done that over the past 90 years, for example, there's tens of thousands of listed stocks in the US over that period, but only four percent of listed stocks delivered all the net wealth if held over that 90-year period. And the other 96 percent delivered poor returns.


Now, one way to interpret this result is that we have this Darwinian jungle of businesses that through mutation, selection, amplification, end up generating these outlier results. However, as we mentioned, during these technological shifts, you have an explosion of new businesses. You do really have to cast a wider net and perhaps have a more diversified portfolio at first, and then as the process of evolution unfolds, you can add more wood behind the arrow to those businesses that are turning into winners and then cull the losers from your portfolio, because it's very hard ahead of time to tell who's going to be the winner in a new category of software, for example, or a new category of technology. The same way our companies are adapting over time, we must adapt our portfolio over time as well.


So, I think position sizing is something that is very personal. We tend to have about 30 positions, it's very top heavy, and that's an outcome of the performance of the businesses, or sometimes it's an outcome of just having more conviction. And as far as holding cash, I'm not a big fan of holding cash. I would rather access our investor base to raise additional capital when we need it.


John Rotonti:

Awesome, Marcelo. We're 10 minutes into this interview and I've heard two terms I've never heard before; Cambrian explosion and Darwinian jungle, so I am loving this so far. We talked about how you run a fairly concentrated portfolio of about 30 stocks, and don't hold a lot of cash. How long do you typically research a new idea before you have enough conviction to decide to buy the stock?


Marcelo P. Lima:

It really depends on the business. If it's something that you have a very high level of overlap or you have a lot of transfer learning that you can apply from other similar businesses, it's always going to be a shorter process. If it's something completely new, a new category, something you're unfamiliar with, you really have to go dig deep and understand the background of the industry, why is this new organism being formed, right? Why is this animal in front of me? What does it do and what's behind it? Our process is really to try to understand a business and its DNA better than anybody else and really get a feel for the company's culture. Today, that's easier than it used to be, right? If you think about when I was starting out, the big advice was, read all the filings. And of course, you still have to read the filings, but today, you have a lot more tools. You've got YouTube, podcasts, Twitter.


Integral to the process is visiting the company and attending... in our case, we attend developer conferences, we try to get our hands dirty with the product, talk to customers, find out who the competitors are. Why is this company winning and why will it continue to win in the marketplace? That's very important to understand.


John Rotonti:

Part of the research process is valuation, and so my question on valuation is, do you build models and focus on discounted cash flow, or DCF valuations, or do you think about valuation using some other methods such as P/E ratios, or free cash flow yields, or whatever?


Marcelo P. Lima:

Valuation is extremely important. You can buy the most wonderful business in the world, but if you pay too high a price, you're not going to see a return. And of course, all of us probably in this broadcast today have a memory of the 2000 internet bubble, and then of course, if you bought stock during the bubble, you might not have seen the peak for another 20 years. So, valuation is very important.


On the topic of models, I build models, I know that my models are wrong, but I still like to use them as an exercise in understanding what are the types of assumptions that I need to make, not only to justify a company's valuation today, but also what's realistic going forward. I know my models are wrong for a variety of reasons, one of which is I can't forecast the company's growth rate 10 years into the future.


One example I like is: imagine building a model of Amazon in 2005, a year before they launched AWS, which not only completely transformed Amazon, but unleashed a technological revolution: cloud computing as a service, and the utility model of computing.


So, models are very important, valuations are very important. I think DCFs are very useful, and I'm not a big believer in starting with a multiple, because there's a lot that's built into that multiple, you really must build the model in detail. We could talk more about that. But I think that the model has to be used in conjunction with all these other factors, the more intangible factors that we talked about as well.


John Rotonti:

Yeah, I love that. I think the idea is, modeling is useful, it's maybe even necessary, but at the same time, it's really hard to model optionality in some of these growth businesses that you invest in and that we're going to talk about here in a second.


Last time we spoke, once again, about a year ago, you said 100% of your portfolio was invested in businesses that were predominantly software businesses. Is that still the case today, and if so, why?


Marcelo P. Lima:

It is still the case, and I think the reason is I continue to find a lot of opportunities, not only in our current portfolio, as we see our businesses developing, introducing new products, etc, but also in new businesses that I'd like to add to the portfolio at the appropriate time. Software has all these interesting characteristics that I really like. There are enormous secular tailwinds, these adoption curves behind pushing the adoption of software forward, very high returns on invested capital, enormous opportunities to keep reinvesting capital at attractive returns into the future, and these companies are in markets that are enormous today, and those markets themselves are growing. And that's because we live in a world where it's very easy today to reach the entire globe.


Software is a very leveraged business model for that reason. We have these public clouds, and billions of people connected to the internet, and we can launch a business and get enormous global scale very quickly. That's something that was impossible 20 years ago. It's just a very interesting pond in which to fish for us.


John Rotonti:

Awesome. So, there are several software companies with a SaaS business model that have all of the things you just mentioned. They have high gross margins, high recurring revenue, very fast top line growth, high returns on invested capital, and the potential for very high free cash flow margins at maturity, but they're currently trading at price to sales multiples of 20 times or 30 times or 50 times. Are these optically high valuations justified?


Marcelo P. Lima:

First, I'll make a general comment on multiples and then a specific answer to your question. I feel that multiples are a little bit abused, as I mentioned. It really should be the outcome of a very careful and considered bottom up model of how the company makes money. For example, if a company sells software on a per-seat basis, you really want to know, how many seats can it sell? What is the revenue per seat? What are the drivers of growth of those two factors? What does the company's cost structure look like today? What can the cost structure look like in the future? How efficient is customer acquisition? What are the unit economics? What's the payback period on that customer acquisition? So, you really need to build the model from the bottom up to get a feel for the economics of the business.


When you do that, and then you ask, "Are these optical valuations justified?" The answer is that, in some cases, they are, and in some cases, they are not. There's really a spectrum. The companies are always moving along that spectrum depending on their future growth rate and their development. How much will they grow or can they invent new businesses that can really inflect their growth? Again, thinking back to that Amazon example in 2005.


There's also this concept of the ambition of the management team and the culture. A new invention, like AWS, and I'm just building this sort of a canonical extreme example just to make a point. But a new invention like an AWS is much more likely to happen inside an organization that has the right culture and that growth mindset and ambition than, let's say in an old school business, run by a professional manager who's worried more about the quarterly dividend, right? So, I think the short answer really is not to rely on multiples as much as to try to really do the work and understand and then build your model and then see what comes out of that model. What kind of multiple comes out of that model. That might be your shortcut, but if you do the work, you'll really get this feel that the multiples sometimes are justified and sometimes they're not, really, is the answer.


John Rotonti:

I love that answer. So, let's discuss some stocks. What is your investment thesis in Shopify?


Marcelo P. Lima:

Shopify’s goal is to build the operating system for e-commerce. We like businesses that are positioned in a competitive way that makes it very hard to compete with them. So, there are many companies competing with Shopify, don't get me wrong, but I feel that their strategy is really superior in a lot of ways. So, for example, they protect against low end disruption by offering a free tier and by having very low prices. So, very hard for somebody to come in and undercut Shopify on price. They also have this very low friction model, right? Anybody can join Shopify and start selling literally in minutes, whether you're a large merchant, and there are some CPG companies that they have a Chief Marketing Officer, and literally, these are true stories, they're sitting at home on the weekend, they're like, "I'd really like to test this out." And they swipe their credit card, and they set up a store, and they start this experiment, as well as obviously very small merchants.


Shopify also has this ecosystem of partners who help clients build stores, and when they do that, they get a cut of the revenues of those clients over the lifetime that those clients are on Shopify. And that builds a very powerful ecosystem around Shopify of partners who really want to help them succeed. And they also have a very successful marketplace, kind of like the Apple App Store where developers around the world will build apps that sit on top and work on top of your iPhone or your iPad, there's also an app store for Shopify, apps that really plug in and amplify the functionality there.


The company has this very intense, focused, mission-driven culture that's really all about turning entrepreneurs into successful merchants. So, everything they do is about improving conversion for the merchants, reducing friction for them and their customers.


Because it's a software-based company, and software is really permeating everything around us, Shopify can really use that muscle to solve more and more problems. So, one example is they recently created a business checking account with no fees that is purely software based for their merchants, and they're building software to enable installment paying at the checkout, for example. So, that's an interesting example on the software side, but they're not afraid of getting their hands dirty on the physical side as well.


They announced the Shopify Fulfillment Network, where they partner with third party warehouses to enable fulfillment, and they bought a robotics company to automate that. It creates this very powerful flywheel where you have more merchants, more data to inform Shopify's machine learning models, which helps improve their payments product, helps improve their conversational bots, helps improve conversion for the merchants, lowers the cost to serve each merchant, and it becomes a snowball that, after a certain tipping point, just how do you compete with Shopify? Unless they really screw up, it's hard for somebody else to have a lower cost to serve merchants, better data, or a stronger flywheel. If they keep executing, it really could become a much larger business.


John Rotonti:

So, I checked a couple days ago, their market cap is $120, $130 billion. So, that's the valuation the market puts on Shopify. Do you think Shopify can double from here?


Marcelo P. Lima:

I'll tell you a funny story. I think Tobi deleted this tweet, but I think it was a couple years ago, somebody said, "I can't wait for Amazon to buy Shopify." And then Tobi said, "Well, I can't wait to buy Amazon in..." I think it was 2039 or 2029, I can't remember. But I'm like, "Wow, that's really ambitious. I like that."


So, $130 billion. If you run a model on Shopify, which I have many times, and with varying degrees of assumptions, etc, you can get low returns from here, and you can actually get attractive returns from here. It's really path-dependent on what they do from here. I do think that the stock can double from here, the question is, how long is it going to take, right? And that's really a function of a lot of things. How many merchants can they onboard? How quickly do those merchants then grow on Shopify?


Shopify has this concept of GMV, gross merchandise volume, how many dollars flow through Shopify for all their merchants. They make about 2.6% on GMV. A company like Etsy, for example, is way higher than that. I think it's low double digits, maybe 9%, 10%, something like that. Amazon is higher still. And of course, this is comparing apples and oranges because those are marketplaces that bring customers to the merchant, but to the extent Shopify can keep helping merchants solve more and more problems, they will be able to develop the economics around that and get more dollars from their merchants as well.


There's an interesting idea that I think is underappreciated, which is this idea of reflexivity. There's a lot of value, as we know, to being a public company, compared to a private company, because if you're public, you have a higher profile, you can pay your employees in stock and reward them that way, and you also have currency for an acquisition. If you have a highly valued currency, you can also raise capital at a very low cost.


By raising billions of dollars to help fund the business, which Shopify has done repeatedly, with the right people behind that, it can really help them fulfill their mission. Whereas if it was a private company, it would be harder for them to raise capital, they would have a higher cost of capital, etc. The short answer is, Shopify can absolutely double from here, the question is how quickly, and we just have to see what they do.


John Rotonti:

Yeah. The other thing I love about the Tobi tweet is, not only does it show he's ambitious and confident, but also very focused on the long term. Like he's in it for the long game.


Marcelo P. Lima:

He talked about building a company for the next 100 years, right?


John Rotonti:

Exactly.


Marcelo P. Lima:

The only other company I know that does that is Nestlé, but Nestlé is already on its... I don't know, eighth or 10th CEO or something, and is growing very slowly, so not that exciting. But Shopify is pretty interesting.


John Rotonti:

Another interesting company and another Motley Fool favorite is Wix. What does Wix do and why do you like it?


Marcelo P. Lima:

Wix, as most people might know, it's a website builder. The largest competitor in this space is WordPress. I built our website, Hellerhs.com. I built that on Wix fairly recently; I tried doing it on WordPress and it's actually pretty hard. I had a professional do it for me, and it was very hard for me to change it. I had admin rights, WordPress was always trying to update some plugin, and a new version of WordPress would come out, you’d get this message “click here to update”. You never quite knew what was going to work with what, whether you're going to break the plugin. You really needed professional management to make it work. Wix just makes it incredibly easy. If you try to build a site on Wix, it's just a huge pleasure, and it's programmable. It also has a marketplace with apps and everything, and they're always introducing new features.


Parts of Wix are more limited than WordPress. I have a big frustration with the blog functionality, where you can’t do some basic things. On the other hand, you can do some very powerful things and you can code. So, I've written my own code to run parts of the website on Wix, and that's super powerful. Wix has grown very quickly. The only other competitor now... really, I think the ranking is sort of WordPress, Wix, and then Squarespace, which might be going public soon [Note: Squarespace is now public]. But the team at Wix is really superb. They've built something very special, and it's really an incredible product. I think if they keep executing well, the sky's the limit, so to speak, because you could really see this becoming a much larger business.


John Rotonti:

Wix and Shopify both help small and medium-sized businesses grow and thrive. Do they compete with each other, and why do you own shares of both of them, if they do compete with each other?


Marcelo P. Lima:

You might call it a Noah's Ark approach. You don't really know who's going to be the alpha predator 10 years from now. They do compete with each other but I think that they approach the problems that they're trying to solve very differently, and also, they attract different types of customers, initially, at least. Wix is more of a content management system, let's say, where you want to expose your content. You might have a portfolio, maybe you're a lawyer, a dentist, you want to have a blog, whereas Shopify is really more geared towards, "I need a store, and I need a store that's very efficient, that has high conversion, that has integration with email marketing, and Facebook ads.”


Now, they do bump into each other, because once you're on Wix, you can set up a store on Wix. You can take appointments. They do step on each other's turf, and I think that that's almost inevitable. You see that across a huge category of software. But I do think it's plausible that, let's say, 10 years from now, 15, 20 years from now, I think it's plausible that Wix ends up as the largest website builder in the world serving creatives of all types who maybe don't need a store as their first order of business, and then Shopify ends up as the largest independent e-commerce platform for merchants who are really focused on being merchants.


John Rotonti:

Awesome, Marcelo. I want to move on to Slack, which as we know, has become a verb. People say "Slack me." But my question is this, has Slack met its match with Microsoft Teams?


Marcelo P. Lima:

That's the question on everybody's mind, and I think the media does a really good job of propagating this idea that Teams is killing Slack. If you're an uninformed observer, and perhaps even a mildly informed observer, you might reach that conclusion. But if you do some digging, you realize a few things. First of all, Teams is doing extremely well now, but the use case is very similar to Zoom's where it's primarily video, and the fundamental innovation of Slack is really creating this channel-based communication that's a replacement for internal email. It vastly improves internal collaboration inside companies. The software has thousands of integrations with all the other software that companies use to run their businesses. HR systems, document management systems, etc, all this stuff is really well integrated into Slack. For large enterprises, their goal is to be the two percent of your IT budget that leverages and dramatically improves the other 98 percent of your spend.


On channel-based communication, Teams has a hard limit on that. You can't create a certain number of channels beyond their limit, and large enterprises very quickly reach that limit. You literally have no choice; you've got to switch to Slack. What's interesting is that recently, Slack built this thing called Slack Connect. Let's say you're an organization, you've got Slack for your internal communications and organization B here with Slack for its internal communication, you can now create a tunnel between these two companies and have shared channel that's secure, has its own document retention policy, it's got its own encryption keys, and it's really created this enormous intercompany network effect, where now my business is happier if you are a Slack user and vice versa.


It creates this very interesting dynamic for inter-company collaboration, and it's really a game changer. It's a new feature. Customers so far absolutely love it, and it took Slack years to completely re-architect the software to make this happen, because it's complicated, and it's not something that Teams can do easily if they can do it at all.


Then you look at Slack adoption; they're really growing fastest among the largest enterprise customers, all of whom are Microsoft Teams users. The evidence seems to be that these products maybe are complimentary. Slack integrates really well into Teams, and Teams is really a skin for SharePoint files and can be used as a very good browser for SharePoint files. I think the summary is: if you take the time to really understand Slack and what they're building, and the company’s culture, the management team, and all that, it's just very hard not to be excited about Slack.


If you look at the size of the business, $18 billion dollar market cap into a market... Microsoft is the largest enterprise software vendor, and they're like 7% of total enterprise spend, and that's a trillion plus company, so there's a lot of room for Slack to be much bigger in the future. [Note: in early 2021, Salesforce acquired Slack for nearly $28 billion.]


John Rotonti:

I agree that it's a potential game-changer. Internally, company employees will say, "Slack me," to someone else, but soon I think we're going to have B2B Slack where businesses tell another business, "Slack me."


Marcelo P. Lima:

That's happening. If you listen to the last earnings call, they give examples of companies that want to better support for their customers, so they'll actually pay for the customer’s seat on Slack so the customer can talk to them through these shared channels. Slack will probably find a more elegant solution for that.


Then there's the emerging use case of sales. Suppose you have this complex sale you need to make that involves a lawyer and different parties. You set up a shared channel, and the sale becomes a lot smoother and closings happen at a much higher rate through that shared channel.


Slack co-founder and CEO Stewart Butterfield said in the last call, "It used to be, if you buy Slack, you got better collaboration. Now it can actually be: buy Slack and increase your sales." And that's a very interesting pitch. So, this is a very new use case for a very new piece of functionality, and they're learning very quickly.


This is a feature of these software as a service companies; they have a very tight feedback loop between introducing a product, getting the feedback, and innovating. Whereas the old school business model of producing a widget in a factory, putting it out there on the shelf, trying to get feedback from the customer, was very disjointed and it took a long time.


John Rotonti:

Moving on to digital payments, you own two of my favorite digital payment companies in PayPal and Square. Let's start with PayPal. What is your investment thesis for PayPal?


Marcelo P. Lima:

There's this concept in startup investing called product/market fit, and this is when your product is so good that the market just starts banging on your door for it, the phone is ringing off the hook, your website just can't stay up because all the customers are flocking to it. And there's nothing quite like that in public companies, but sometimes it gets close. If you look at the last quarterly earnings for PayPal, it was quite astonishing. The company is just firing on all cylinders, they had the strongest quarter in the company's history. Overall, it's a business that's executing very well and really availing itself of this opportunity in digital wallets and P2P payments, and eventually building a digital bank on your phone.


The way I see PayPal is really as a major disrupter in financial services. If they keep executing well, it could become this hub for an enormous number of digital services that they can build on the phone. They have the customer acquisition engine working very well through PayPal and Venmo.


John Rotonti:

I think they have 70 or 80% of the checkout button market share. Amazon checkout is second, but PayPal is just far and away the leader.


Marcelo P. Lima:

Yeah. And it increases conversion. If you have the button there on your checkout, it increases conversion. That's also true about Shopify with Shop Pay. A lot of the thesis is really about reducing friction. Apple Pay is incredible. You go to a store and just tap a button. You don't have to type in your name or address. It’s a big turnoff nowadays to have to do that. Shop Pay makes that super easy, and PayPal as well. Now they bought Honey, which provides more data to close the loop and really, grease the wheels and make the flywheel turn even faster.


John Rotonti:

What about Square? What do you like about Square?


Marcelo P. Lima:

Square approaches financial services with a very mission-driven view of the world, and that's to increase economic empowerment. The way Square started is really textbook disruption theory by Clay Christensen. They started out with this dongle that you plugged into your iPhone to accept credit cards, going after the unbanked, really a completely ignored market. After capturing that, they started going up-market, and now they have these beautiful point of sale terminals for larger merchants. It's a company that has a very strong design and engineering culture and a product sensibility that's really reminiscent of Apple.


The point of sale is used as a means of acquiring the customer. They sell the physical hardware at a loss, but then the unit economics on top of that, the payback period, is extremely attractive. That seller ecosystem is one part of the company. The other part is Cash App, which is an incredible application for your phone. They're sort of ninjas in social media viral marketing. There's Cash App Fridays on Twitter, where they give out money to random people, and of course, it enables very easy P2P payments. They have rewards through Boosts. You're walking by a store and they'll give you 10% off on a coffee or something like that. It's really cool. Cash App also allows you to press a button and get your own card and customize the card, and it's all free.


They're building more functionality and turning Cash App into a digital bank. You can buy bitcoin with no fees, you can buy fractional shares of stock with no fees. Berkshire Hathaway trading at hundreds of thousands of dollars? You can buy 10 bucks worth of it if you want with no commissions. It's a very powerful tool. If they execute Well, it's a neobank, a digital-native bank. We’ll see how the company develops, but it's really a very interesting approach to getting there. [Note: recently, Square announced a deal to acquire buy now pay later provider AfterPay.]


John Rotonti:

The use cases and the functionality of Cash App never cease to amaze me. It's like they're always coming out with another great use for Cash App.


Marcelo P. Lima:

Yeah, John. And the kind of talent that these companies attract is another underappreciated point. If you're the best and brightest in the world, would you rather go work for an old school business that's barely growing and is barely relevant or would you rather work for a business that's in the zeitgeist that everybody's talking about, that's exciting, that has a mission-driven culture?


I think the question answers itself. In the case of Square, I was amazed. I can't remember his name now, unfortunately, but I found this very talented designer on Twitter, and he does just incredible animations, and he works for Square because they do these amazing fluid renderings and animations for their ads and the application itself, so he's applying his talent to that, which I thought was really incredible. [Note: his name is Sekani Solomon.]


John Rotonti:

I love that you have highlighted design and that you noted the similarity with Apple. On The Morning Show where I'm a co-host on Motley Fool Live, I've said that Square is the company that reminds me the most of Apple because they excel at hardware, software, services, and design, so similar to what you just said there.


Moving on to Twilio, can you explain what Twilio does and why you're invested in Twilio?


Marcelo P. Lima:

In very simple terms, before Twilio existed, if you wanted to use a computer to make a phone call or send a text message, that was hard, if not impossible to do. Twilio started out by making that extremely easy, with just a few lines of code. They turn telephone switches into software, very loosely speaking, but then they kept building on top of that. They created this layer of programmable communications, and now they're building on top of that. They kept asking the question, "How do we better serve our customer, developers?"


Developers wanted to send email. So, Twilio went out and acquired SendGrid, which was a company very similar to Twilio that was building programmable email. And then Twilio started seeing developers building these incredible applications using Twilio's building blocks. For example, there was a bank that was building an entire call center on top of Twilio. And so Twilio thought, "Well, maybe there's an opportunity here." And they took some of their own building blocks and they built a higher level application, also fully programmable, which is a call center, and that's called Flex. And so, they'll continue to do that, they'll continue to identify use cases that customers are doing all this heavy lifting and try to make it easier and more frictionless for them to develop that.


Today Twilio calls itself the leading customer engagement platform. The mission is to create this unbreakable relationship with your customer. They recently acquired Segment. The deal is going to close in Q4. Today you have all of these different interactions with your customers. There are phone calls, text messages on WhatsApp and iMessage, email, and perhaps the customer calls into your company and talks to somebody in a call center. They also have website clicks, and all these things live in different systems, and they're all siloed. Segment collects all that data and puts it in a data warehouse for you in a way that allows you to connect all that data and create a centralized, unified profile of your customer.


This has been the holy grail of CRM (customer relationship management) for decades, and nobody's really been able to get that holy grail, put all this siloed information into one customer profile. So, it's a very exciting acquisition and we'll see how the company develops, but it just has this incredible momentum. They keep hiring incredible talent, they keep acquiring incredible talent, so it's very exciting business to see what they build. It's one of those where you look at what it's doing today and how big it could get, and it just seems like there's a lot of potential for the business to be much bigger. [Note: since this interview, the Segment acquisition closed and Twilio has continued on acquiring interesting businesses.]


John Rotonti:

You also own two consumer-facing entertainment technology businesses in Roku and Spotify. Please tell us why you like Roku and Spotify?


Marcelo P. Lima:

I'm glad you put these two together because I think they have some similarities. Linear TV, just watching regular TV, is a roughly $70 billion dollar industry in the US. That's just the ad-supported side. Then there's another $80 billion from subscription revenues, and that's just in the U.S.


Years ago, I recall watching CBS's 60 Minutes, and the commercial break came, and I had to sit through the golfer Phil Mickelson talk about Enbrel, which is a drug for arthritis, and I was just like, “Oh, man, I don't want to sit through this. This is such a wasted opportunity. They could have shown me an ad for something cool that I actually care about” right?


So, I'm a big fan of targeted advertising because it allows businesses, big and small, to reach customers with relevant products. This has been extremely successful for Google and Facebook, of course. I'm a big user of Instagram, and as I scroll through Instagram, I get some really cool relevant ads of things that I... I actually bookmark some of the ads, like, "Oh, I want to come back to this product later," which I probably never would have done in the old days of TV.


Roku is bringing this programmability and targeting of advertising to television. The same way we talked about Square and how it sells the point of sale terminal at a loss to acquire customers, well, Roku does something similar. They sell, at a very small margin, the Roku sticks that you can buy just about anywhere, and you plug that stick into your TV and now it's a Roku TV, or you can just go out and buy a Roku TV itself, because they licensed the operating system. About a third of all TVs sold in the US are natively Roku TVs. Now you have a Roku TV. What do you do with it?


Well, the operating system, the user interface, is much better than your cable box, and you can watch this enormous amount of content, and it could be either ad-supported, with much better ads than that ad experience that you've had before, or you can also subscribe to Netflix, Disney+ and others, and Roku gets a cut. You can do a mix of that. You can decide to watch a movie ad-supported and then switch over to something that you pay for.


The company has this incredible management team and the metrics are just exploding in the right direction. It turns out that time spent on Roku is disproportionate relative to the amount of ad dollars that have gone to Roku. So, there's really literally a tsunami of dollars coming. That's a very interesting dynamic. We saw that happening previously, with mobile advertising where time spent on mobile was very large and ad dollars still hadn't gone to mobile. And of course, that's been very successful for Facebook and Google.


Spotify has a similar dynamic in the sense that there's about $18 billion dollars of terrestrial radio ad spend in the US alone, and Spotify can offer you a much better experience on the ad-supported side. Not only that, but there's going to be an explosion of ad inventory because of the rise of podcasts, which is not something that even existed in terrestrial radio. Spotify is different in the sense that the ad-supported part of the business is really just a funnel for their premium subscription business. They do extremely well converting ad-supported users to premium users.


It's a company that has this incredible management team. I'm a big fan of Daniel Ek, the founder and CEO, and he has this vision of creating the largest audio-first company on the planet. They've made a number of acquisitions in podcasts, and they're investing in original content. In that sense, it's a little bit like Netflix in that the better content they have and the better user experience they have, the more they please their members, and that improves engagement, it lowers churn, and lowers customer acquisition costs. So, they're really building this incredible flywheel that could be much bigger in the future. [Note: since this interview, Roku has also invested in original content, betting on a similar outcome. It appears to be working.]


John Rotonti:

Speaking of consumer-facing businesses, one of my favorite companies is Peloton. I'm just wondering if you've ever looked at Peloton, thought about Peloton, and if so, what are your early thoughts? Could it potentially fit within your investing framework?


Marcelo P. Lima:

Yeah. I'll have more to say about Peloton if we can do it next time, but what I'll say for now is, we were having this discussion about Apple and Square; Peloton is a great example of that, because Apple is really this phenomenal hardware company that differentiates it with phenomenal software.


It sells premium hardware and premium software with a very superior integrated experience, and you can see that with Peloton as well. But I think we should table this for a future discussion when I can talk more about it.


John Rotonti:

Fair enough, and I look forward to having you on again very soon. I'm going to try another one. What about Zoom? Have you looked at Zoom?


Marcelo P. Lima:

Yeah. So, a funny story about Zoom is, I modeled Zoom at the IPO, I thought it was a bargain, because they were already profitable, and growing very fast. And we have this account with one of these large banks as one of our brokers, so I said, "Look, I'd love to buy a position in Zoom," I told them how much, and they allocated us some Zoom, but it was like 100 shares, which was kind of them, but it doesn't really move the needle, right?


Zoom, by the way, is a great example of the problem with models. I wrote a piece recently called, Models, Good and Bad.


Going back to AWS, AWS wouldn't have been created at all if Amazon had stuck to its models. That's an interesting story. So, back in March [2020], before we knew the effects of the pandemic, my Zoom model told me that Zoom stock could deliver a mid-single digit IRR into the future. But that's not what we aim for.


Since then, the stock is up 4X, and that's because my model showed Zoom doing $630 million dollars for this whole year, and of course, they've done more than that last quarter. Obviously, you can't really have an investment thesis predicated on a pandemic accelerating your business, but the point of the story is to be very careful of models in a complex world. I still have to digest Zoomtopia [Zoom’s annual conference], which just happened.


It’s a company where they probably are going to build an incredible business. I do think the valuation is kind of bonkers. I updated my model and I still think it's a little bit bonkers, but we'll see what they build.


John Rotonti:

When do you sell a stock or when would you sell a stock out of the portfolio?


Marcelo P. Lima:

The way I see it is, you sell a stock when the company is no longer competitively advantaged. You're evaluating the business and you think, "You know what, I don't think this company can grow as much as I thought it was going to grow, there's too much competition," or something else in your thesis has broken. That's a very good reason to sell. Another good reason to sell is when you find something better, because everything is sort of priced off of opportunity costs.


It's very hard to do any sort of market timing or macro forecasting. All that stuff is more voodoo than reality, so it's not something that I use as a tool for portfolio management. It's really more looking at the business fundamentals and then sense checking my model, and I may make moves in terms of overweighing something if it's cheap and underweighting something if I think the price is egregious, perhaps even getting rid of it.


If we were back in 2000-type scenario where everything is crazy overvalued... There's this book called Bull by Maggie Mahar. If you think we're in a bubble now, you should really read that book because, thin